SEC to Propose Pay-to-Play Rule for Investment Advisors in July

June 11, 2009, Political Activity Law Bulletin

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In response to allegations of "pay-to-play" in the award of contracts to manage New York pension funds, the Securities and Exchange Commission ("SEC") plans to propose at the end of July new restrictions on firms subject to the Investment Advisors Act of 1940. The SEC intends to propose a rule modeled after MSRB Rule G-37 (a municipal bond rule) that would restrict investment advisors from managing state and local governments' money if the firm or its executives make certain state or local political contributions.

This is not the first time the SEC will take up a review of these concerns – in fact, the rule the SEC intends to re-propose was first considered in 1999. If enacted, the rule would parallel the restrictions currently imposed by G-37 and impose those limits on investment advisers. Specifically, the rule would prohibit investment advisers from providing advice for compensation to a government entity within two years following a political contribution to an official of the government entity from (i) the adviser, (ii) any of its partners, executive officers, or solicitors, or (iii) any PAC controlled by the adviser or its partners, executive officers, or solicitors. The rule would exempt contributions of $250 or less in the aggregate to candidates for whom the donor is entitled to vote. The rule also would impose a record-keeping obligation on investment advisers.

As mentioned, the rule's prohibitions would be triggered by a contribution to an "official of a government entity." "Government entity" would include all state and local governments, their agencies and instrumentalities, and all government pension plans and other collective funds. An "official" would include incumbent candidates or successful candidates for office if the office (or the office's appointee) is directly or indirectly responsible for, or can influence the outcome of, the selection of an investment advisor.

This proposed rulemaking arises out of allegations that money managers and their placement agents have used ties to public officials and kickbacks to buy and sell access to the $2 trillion currently invested in and on behalf of U.S. public pension systems. New York state has already banned the use of placement agents outright, and other states may follow suit. In the most recent example, the California Public Employees' Retirement System ("CalPERS") adopted a new policy on May 11, 2009, which does not impose an outright ban but instead requires external managers to disclose fees and other information about the placement agents they hire to seek CalPERS business.

This area of law is rapidly developing and various state governments and other regulatory agencies can be expected to add different approaches to these concerns in the months ahead.